How the Approach to Valuation Frames Success for Diligence and Integration

“If you look at what goes into the integration plan, it’s everything that you find out in due diligence.”

How the Approach to Valuation Frames Success for Diligence and Integration

Last week’s interview was with Erik Levy, Group Head Corp Dev and M&A at DMGT PLC. Erik has completed over 150  acquisitions, minority and venture investments and strategic partnerships.

The topic of discussion is how successful Diligence and Integration planning frames success of M&A and Valuation.

Contrary to popular belief, Diligence and Integration actually frames the success of valuation.

Valuation needs to be adjusted all the time as you discover more things in the process. The diligence and integration planning are the inputs and the valuation is the output.

The day you start due diligence is the day you start the integration plan. You have to bring in the integration team very early, and involve the people who did the diligence in the integration planning. 

Also, the team that did the valuation model, due diligence reports and integration plan, all needs to be in constant communication with each other so that everyone knows exactly what everyone else is doing. 

There are a lot of reasons why deals fail but It is never about someone over paying for a deal.

The biggest contributing factor of failed deals is the lack of integration planning, or a very poor execution of the integration plan.

The next in line would be capital structure behind culture and compatibility. 

Text version of interview

Can we kick off with a brief background on your experience and a little bit about DMGT?

I have been doing corporate development for over 20 years at a number of different organizations. After business school, I spent around four years doing management consulting. After that, I went to Primedia, a diversified media company, started in an FP&A role, and then transitioned into corporate development. As part of my role there, I did a good number of acquisitions and alliances, but also divestitures. From there, I went to LexisNexis and then to DMGT, where I have been now for almost 10 years. 

In DMGT I lead corporate development and M&A. We are a holding company and you may be familiar with some of the companies that we have as our operating subsidiaries. These companies fall into two groups, where we have BDC businesses, such as The Daily Mail, The Mail Online, and B2B businesses, where we have a number of must-have information providers to professionals in different industry segments, such as Hobsons or Trepp. 

We do both bolt-on acquisitions, as well as acquisitions of new operating companies, and we also do some minority investments, alliances and from time to time, we do divestitures as well. 

Let’s talk about what types of valuation should be done at different stages of an acquisition process.

At indicative stages of an acquisition when you are doing some outside-in work on the target or you are just getting into a deal process you probably want to do a very high-level valuation. The goal is to model out the target, think about things like revenue, what type of market share pricing volume assumptions should you be taking into account in your valuation, what kind of operating leverage you can get in terms of how expenses are going to scale with revenues and then what type of investments are going to be needed. 

There are a couple of reasons why you want to keep it at a high level at an early stage. One is, the information you have on a target can be limited at the beginning, and you don’t want to overcomplicate the valuation with low-fidelity data. 

The other is that doing detailed valuation is a significant call on the time of not only the people running the valuation but also people who might need to provide inputs. You want people to be focused on detailed assumptions only if this is something you are really going to be pursuing in a meaningful way. 

The third is, if you have a very detailed model, you will need different people in different disciplines, but you need to keep a small group in order to maintain confidentiality. Once you start to focus on a particular target in the post-LOI stage, then you need to have a relatively detailed model that has revenues modeled-out at the product and product market customer segment level and have it be a volume price-based model.

In terms of mapping that out in life stages, would you break it down to pre-LOI and post-LOI?

Generally, yes. It also depends on the amount of resources you have and how many deals you tend to look at. There is just a practical limitation on the amount of information you are going to have pre-LOI and in most cases you aren’t going to have enough information to have a very detailed model. In the initial modeling, you want to be focused on the 80/20 rule. Once you get past the LOI, that’s when you really need to start diving into nitty-gritty issues and building a detailed model. 

How does the approach to valuation affect the success of diligence, integration, and overall success of an acquisition?

In my opinion, valuation, diligence, and integration are inextricably linked.

Valuation is very outward driven, and the diligence and the integration planning are the inputs. Having a rigorous valuation methodology keeps you honest and ensures that you are not only looking at the quantum but also the timing of synergies and the performance of the base business. If you do diligence and integration planning in tandem, you are also going to have a robust and systematic valuation process. 

So if you look at the process of diligence and integration, it’s continuous and there are all these discoverable things you can’t predict. Would you adjust the valuation as you go through the process?

Absolutely. The integration plan and the valuation model are living documents and due diligence usually has a discrete beginning and an end to it. Often when you go into a process you will have a valuation range, but as you go through the process you are going to be getting that 80/20 down to the 95/5.

I don’t think you are going to discover major changes to it, and oftentimes as you go through an acquisition you’ll find some additional upsides that you hadn’t initially thought. The pluses or minuses that you discover may allow you to go higher, but only if you need to and can.

What are the key considerations in executing the valuation, diligence, and integration planning that should be taken into account to maximize the success of a transaction?

Once you get post-LOI, at a valuation side, you need to be doing it at a relatively granular level and doing it at a price and volume sort of granularity. You need to be modeling out revenue synergies and getting the timing of those synergies correct.

• How are they going to layer in?
• What is the quantum of synergies going to be?
• How long will it take for those synergies to layer in?
• What are the costs that are going to be required in order to achieve these synergies?

You want to be focusing on these questions. 

Regarding cost, you need to be thinking about how they are going to scale over time, both the variable and the fixed cost. If you are modeling out revenue synergies you need to figure out what are going to be the costs that are related to these revenue synergies and also model out cost synergies. 

Who are you leaning on in terms of your resources to really be able to develop this and in terms of making sure you are getting the right people involved?

In terms of modeling, there needs to be an owner of the technical model. It’s important to have someone who has the capability and the bandwidth to run the model. But, that’s very different from who owns the assumptions. The person who runs the model can certainly help develop assumptions, but the person who owns them needs to be someone in the business who is going to be responsible for delivering projections.

You need to have involvement from sales, marketing, product, and people who are developing the assumptions are also the people who need to be doing the diligence. Similarly, on the cost-side, people who develop assumptions that go into the model need to be the owners of the various cost centers.

Ultimately, the CEO and the CFO of the business that’s doing the acquisitions need to own the projections and make sure that they understand the implicit and the explicit assumptions that are being made. Integration planning should start as soon as you start diligence, so it’s often the same people who are doing the due diligence that are going to be involved in developing the integration plan.

Similar to a model, there can be an owner of the integration plan who facilitates bringing together inputs from various people to come up with a plan. Oftentimes corporate development teams have an integration lead, but you can also work with an outside firm to help you pull it together.

Do you have the person who owns the model or maybe the technical person keeping up with upcoming information and using it to update models?

Absolutely. I think everyone should care about updates because that is going to affect everything from the perception of the culture to sales to product. We try to keep everyone updated and use the upcoming information to build our roadmap. We immediately set up a Slack group so we can immediately communicate and keep up.

I am pretty impressed you are using Slack. Are you using other tools for collaborating or distributing information?

We use Microsoft 365 OneDrive to share all the documents. We use Slack, Outlook and OneDrive. 

I got a question from Samantha. At which stage would you write a business case or request sign-off and approval of the acquisition from the board? Would you do it before LOI or after due diligence is complete?

The answer is both. It is different for different organizations. At DMGT, in order to get that buy-in from CO or CFO, we put together a three or four-page document that explains the strategic rationale and the outputs of the high-level model that we’ve put together. Depending on the size, it will go to the ExCo, or the ExCo and the IFC, and we will get their approval to issue an LOI at a certain level. 

You want to put together a brief strategic and financial rationale pre-LOI and then, assuming you put together an LOI, you get to submit your final bid. This is when you go back to the relevant governance spot and do a more detailed paper, but just to the extent that we have more color on the strategic rationale, the financial plan, and importantly, we explain how we are going to do the integration plan and who is going to be involved. 

How should the success of acquisition be measured?

At the end of the day, it should be on how well you attained the strategic and financial rationale that was laid out.  Post-acquisition we have acquisition reviews at regular intervals, usually every six months.

There is some key strategic rationale and key financial metrics that were set out at the time of acquisition and then 6,12,18,24 months we look at how we are performing along with the strategic rationale and then we see how well we are doing on the achievement of the financial projections.

We explain the under or overperformance and the biggest reason to do so is so that we can learn from what worked well and what could have worked better so that going forward we can focus more on those areas where we need to do better. 

How does that play out when you start integrating the company? Don’t you integrate the finances at some point and bring it together?

When you are doing the modeling, you are not only doing the modeling of a standalone company, but you are doing it for the combined company. If I am acquiring something that is integrated into an existing business I may decide to model the standalone business and the synergies separately, but then I layer those into the existing business and put it together and that’s how I’ll measure it. 

I can usually still track these synergies. Let’s say you are acquiring a standalone company that is not going to be integrated into the existing business you still can measure the performance of that standalone company. But, if post-acquisition you make another acquisition things get more complicated to measure. You need to be flexible and perhaps change some of the metrics. Measuring success for more than two years gets to be problematic.

I got a question from Jeff. What have you found works to improve the sense of ownership that the business division leaders have in delivering the synergy projects post-closing?

There are two reasons why you have the acquisition reviews. One is to learn what worked and what didn’t so you can improve the performance of future acquisitions and the other is for accountability and tying compensation to performance, although most CEOs and CFOs don’t need to get reminded of the importance of doing a good job around diligence and integration planning.

There is a long term incentive plan that's based on a multi-year plan, and when they do an acquisition, that multi-year plan gets adjusted by the acquisition. So they are going to be responsible for delivering the numbers that were set out. 

Do you ever feel the difference in terms of perception and mindset between deals that are sourced through corporate development and those spruced through the business?

I tend to think that the best deals are the ones that are sourced from the BU because they are the closest to space, but the reality is that many things do come from corporate development. I never got the feeling that the CEO knows it is a good deal but is trying to forward it because it came from corporate and is not sourced by them. 

I got another question from John. What are your thoughts on the best tools to show progress against integration progress? Is there a way to give extended teams a self-service view of how their work is contributing to the value proposition put in the buy plan/ business case?

We don’t have a specific tool other than Excel. There are specific tools that help with integration and several software packages out there that help at all different stages of the M&A process, but we haven’t subscribed to them yet. We look at the information we gather in Excel to map out how we are doing. Just by looking at the financials you can model out the first year and see how you are doing with sales, sales volume, and other metrics that are trapped in the financial plan. 

What is the biggest reason deals fail?

It’s usually not because someone overpaid for a business, it's more that they didn’t do sufficient integration planning or any integration planning at all. Or, they could have made a decent integration plan, but just didn’t fully see it through. Sometimes, there is a tough capital structure where a company hits a bump in the road and that draws all the attention from management from running the business to dealing with the capital structure. 

What’s the craziest thing you’ve seen in M&A?

The latest was Trump wanting to take a deal fee on the sale of TikTok. He said he is OK if Microsoft buys TikTok, but he thinks the US should get part of the proceeds. 

Aside from the government trying to take a deal, a while ago we had a bunch of print assets and this was right before the Internet was becoming a fact. The people who were running the print business said there was a company that has similar topics they have in print, but they are all online. Acquiring this company was supposed to be a way of creating online versions of our print. They did the acquisition, but when the time came to integrate the business they realized that the editors had completely different writing styles, and teaching the print folk how to optimize for search engines was a difficult task. 

It very quickly became clear that this was not the solution to bring our current assets online. The businesses actually stayed separate and we ended up selling the online business. You preserve some value by not integrating. 

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